Crude to fall to $70 next year, report predicts

Analysts predict crude priceswill continueto slide next year

U.S. benchmark crude prices will fall to $70 per barrel next year, according to a forecast published by Goldman Sachs on Monday, suggesting that the recent and pronounced slide in oil prices isn't just a temporary phenomenon.

The report came at the start of a week when some of the world's biggest oil companies - including BP, Royal Dutch Shell, Chevron and Exxon Mobil Corp. - are poised to deliver quarterly reports and face Wall Street analysts' questions, in some cases for the first time since oil prices began plummeting earlier this year.

And there's one big question on the minds of those analysts.

"Now that oil is down 20 percent," said Raymond James analyst Pavel Molchanov, "it's obviously worth asking: Will some of these companies rethink their capital spending plans or cut their capital programs?"

He said he doesn't expect massive across-the-board cuts, but companies will likely pare back spending. And executives this week are likely to be coy about those spending levels, since they are still planning their budgets.

Analysts and other experts will try to read the tea leaves in hopes of gleaning signals about how the industry will react to the changes.

The budget process comes as many major oil companies had already signaled plans to keep their 2015 capital budgets level or slightly lower than current levels, even prior to the crude price slide. The crude slide could give them even more impetus to instill discipline.

"If we're at $75 or $80 oil by the end of the year, we'll start seeing companies pulling back," said Brian Youngberg, an analyst at Edward Jones.

The Goldman Sachs report predicts that West Texas Intermediate, the U.S. oil price, will fall to $70 per barrel in the second quarter of 2015, while Brent will fall to $80 per barrel during the same period. Brent crude, traded in London, is a major benchmark price for purchases of oil worldwide. Brent crude is extracted from the North Sea. West Texas intermediate is traded on the New York Mercantile Exchange and is the U.S. benchmark crude.

WTI closed at $81 per barrel Monday afternoon, down $0.01, while Brent closed at $85.83, down $0.30.

The decline in oil prices is because oil production growing at a faster clip than demand, leading to a global oil market that's oversupplied. The report called the slide inevitable, noting that "getting to a point where the market shifted back into surplus was only a matter of time."

Youngberg said the biggest players in the oil industry have strong balance sheets and can afford to work through cyclical dips in crude prices - if they want to. Major oil companies recognize they have no control over the cost of oil and historically manage around them. "You just kind of weather through it," Youngberg said. "There's highs and lows."

He also speculated that declining crude prices could prove to be positive for oil companies, since many have had a reputation for overspending - by pursuing complicated projects rife with overruns - in recent years. Shell, Chevron and Total, among others, all announced plans this year plans to pull back on capital expenditures even before crude prices took a dramatic dive.

As crude oil prices continue to plummet, so too do U.S. gasoline prices. Now, more than half of the country's gas stations are selling regular gasoline at less than $3 per gallon, according to GasBuddy, which crowd-sources retail prices.

The last time the country's gas stations were selling sub-$3 gasoline was in December 2010. The average for the Houston area was $2.84 Monday evening, the site said.

Crude oil prices will be at their lowest points of 2015 during the second quarter. During the rest of 2015, the Goldman study predicts $75 WTI and $85 Brent.

In the longer-term - 2016 and beyond - it forecasts WTI at $80 and Brent at $90. That rebound on prices will likely occur when OPEC countries are expected to cut their own production, once it's clear that U.S. production growth has slowed as well, the report predicts.

Energy stocks sank on the news of the report. The S&P 500 Energy Index, which includes top energy stocks, was down 2.03 percent Monday while the S&P 500 as a whole was down just 0.15 percent.

Local energy companies that took big hits to their stock prices Monday include exploration and production company Sanchez Energy Corp., down 10.1 percent; oil field service company Halliburton, which was down 6.1 percent and its rival Baker Hughes, down 4.4 percent.

Still, the continued drop in crude oil prices - at their lowest level since 2012 - is unlikely to cause an immediate slowdown in activity in U.S. shale plays. Molchanov said there's a misconception that if WTI is around $80, U.S. shale plays won't be profitable and drilling will dramatically slow.

He said the break even point in many U.S. shale plays is well-below $70, and in some places, it could be below $50. "So the (profit) margins are lower today," Molchanov said, "but the wells are economic."

If companies reduce spending and pull back on drilling, it won't be because wells aren't profitable. It will be because their cash flow has slowed, and they've made a decision to be more fiscally disciplined, he said.

There could be a silver lining for U.S. oil companies. Worldwide, oil is priced in dollars, and the dollar is currently strong relative to other currencies. That makes oil more expensive for other parts of the world than it is for Americans, which has contributed to slowing demand.

But the strong dollar also gives U.S. firms more purchasing power. "They're flush with cash," said Kenneth Medlock, senior director of the Center for Energy Studies at Rice University. "With a stronger dollar, they're in a great position to acquire assets overseas. Don't be surprised if you see big investments made offshore in the next couple of years."

Until recently, U.S. producers have benefited from oil inventories that had remained relatively stable since mid-2012, as shale production has coincided with disruptions among OPEC suppliers. At the same time, they've enjoyed growing global demand for crude.

Today, Goldman Sachs writes, that equilibrium is unraveling. U.S. production is strong but OPEC disruptions that has once faced some of its member countries like Libya, Iraq and Iran are easing.

But leading OPEC countries like Saudi Arabia aren't expected to slow their output in the near-term in order to keep prices high as they have in the past.

Saudi Arabia has likely determined it doesn't want other OPEC countries to cannibalize its share of the global oil market and will continue to sell oil at its current volumes, even if doing so will keep prices low, Medlock said. He added that it costs Saudi Arabia little to produce oil, so it can still make strong profits at those levels.

Still, the authors of the Goldman Sachs report note that their forecast may change. And others have observed oil prices are notoriously difficult to predict.

"If I can predict oil prices, I'd be sitting on a beach in Galveston and wouldn't come to work and wouldn't mess with this production business," said Steve Chazen, chief executive of Houston-based Occidental Petroleum Corp. in a conference call with analysts last week.

Previously, he covered energy for the Houston Chronicle. Before that, he wrote about transportation and municipal finance for Governing magazine, which is read by state and local government officials nationwide. Holeywell’s previous work has been published by the Washington Post and USA Today, and he has appeared on CNN and public radio to discuss his articles. Holeywell, a Houston native, graduated from George Washington University in Washington, D.C.